Gold Market Cheat Sheet (August 29, 2011)

Gold Market Cheat Sheet (August 29, 2011)

For the week, spot gold closed at $1,827.95, down $24.15 per ounce, or 1.30 percent. The U.S. Trade-Weighted Dollar Index fell 0.38 percent for the week.

Strengths

• This week we saw gold reach another all-time high of $1,911.46 a troy ounce, set in late trading on Monday. Throughout the week, however, we witnessed considerable movement of the precious metal’s price. The funds performed relatively well during such a volatile week. Considerable weight in the seniors continued to work in the funds’ favor, despite juniors and venture stage companies not seeing significant investment interest. We also witnessed strength in gold equities’ performance this week, which is contrary to their generally weak performance relative to the bullion.
• The World Gold Council said in a report Thursday that gold ETFs added nearly 52 metric tons of bullion in the second quarter, reversing the outflows from the first quarter. ETFs listed around the world that invest in gold hold more than $1 trillion in total assets as investors continue to move into metals ETFs to hedge against inflation and seek shelter from sovereign debt uncertainty.
• The World Gold Council recently highlighted that current gold price levels are being supported by central banks; they have been continuing to accumulate positions in gold over the last six months. In February and March, the Bank of Mexico accumulated almost 94 tons of gold, representing the largest accumulation of gold by a central bank in over a decade. The second-largest growth in the precious metal’s accumulation was made by South Korea in June. With the exception of the Philippines, every central bank has reported increased reserve holdings over the last six months. Kazakhstan’s Central Bank has plans to add to its gold reserves by exercising its right to buy the Central Asian state’s entire bullion output, according to Mineweb.

Weaknesses

• The performance divergence between the junior and venture stage mining companies relative to their senior peers has not seen such spreads since the 2008 credit crisis.
• Gold suffered its largest two-day absolute fall in more than three decades, dropping $160 per ounce between Tuesday and Wednesday in a move that highlighted the dangers of an asset viewed as a haven. Spot gold prices fell to a session low of $1,750.55 per troy ounce from $1,911.46 a troy ounce. The previous, largest two-day absolute drop was in January 1980.
• Late Wednesday, CME Group, the operator of New York’s Comex exchange, increased gold margin requirements by 27 percent, following a 22 percent increase two weeks ago. The margin increase came as gold futures fell more than $100 during the day, in one of the steepest falls ever. The Shanghai Gold Exchange (SGE) raised trading margins on three gold spot-deferred contracts to 12 percent from 11 percent from August 26 to limit trading risks following recent wild price swings. It also widened daily trading limits for those contracts to 9 percent, up from 7. This is the second time the SGE has raised collateral requirements on gold forward contracts this year, as international gold prices hit a series of new highs over the past few weeks. Interestingly, Central Banks’ purchases more than quadrupled for this same period.

Opportunities

• Despite the correction, investors noted that gold remains the second-best-performing commodity so far this year, up 24.6 percent since January. Silver is the best-performing commodity, up nearly 30 percent since the beginning of the year.
• Net central bank buying, renewed investment demand for gold and record levels of inflows into Southeast Asia are providing positive fundamental drivers for gold. Coupled with ongoing eurozone debt crisis, concerns over the U.S. debt and the prospect of another round of Quantitative Easing (QE-3), there is a continuing sound market for continuing strength in gold.
• RBC analysts believe investment upside opportunities lie within the gold stocks. Although gold stock performance is lagging presently, RBC analysts believe that the disconnect can be attributed to concerns over rising operating and capital costs, a shift out of equities in general and doubts over the sustainability of a higher gold price over the long term. They believe gold equities are poised to outperform the gold price as investors take advantage of growing free cash flow that they forecast to be generated over the next 12 to 24 months.

Threats

• Doug Silver, founder of International Royalty Corp. and portfolio manager for Red Kite Management, recently advised that the “mining ‘supercycle’ has stalled.” He highlighted that mining companies are now contending with a global debt crisis, smaller areas available for exploration, and competition with Chinese mining investment, as more metal goes into the Shanghai Exchange and less metal goes to the London Metals Exchange. He also made the connection between the world’s top consumers pulling back on their consumption in the wake of the global economic crisis and the fact that U.S. jobs are moving overseas because domestic companies have no incentive to invest in America, both contributing to an overall decrease in living standards, reducing metals consumption in the long term. He further commented that major western mining companies are concentrating on mega mines with long mine life and multi-billion-dollar capex budgets, which leaves very little available capital for mid-tiers and juniors.
• Greece has been forced to activate an obscure emergency fund, the Emergency Liquidity Assistance program, for its banks because they are running short of collateral that is acceptable to the European Central Bank. Greece’s bailout faltering has been in the news lately and this appears to the last stand for Greek banks, according to the London Telegraph. The ongoing debate of the eurozone’s economic crisis continues.
• South Africa’s state-owned power utility, Eskom Holdings SOC Ltd., may raise power costs by 60 percent over the next three years, raising the average electricity tariff to about 75-80 cents per kilowatt by 2016. This could potentially create downward pressure on margins for all South African businesses.